John Baxter is a highly valued employee of Stern Inc. His marginal tax rate is 46 percent and he would like to acquire a vacation property. To assist with this purchase, he has asked the management of Stern for a $350,000 interest free loan. At this time the mortgage rate for vacation properties is 4.5 percent and the prescribed rate is 2 percent. Stern is subject to a marginal tax rate of 26 percent and has alternative investment opportunities that earn 7 percent before taxes. Should Stern Inc. grant the loan or, alternatively, provide sufficient salary to carry an equivalent loan from a commercial lender? Explain your conclusion.

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The Answer of John Baxter is a highly valued employee of Stern Inc. His marginal tax rate is 46 percent and he would like to acquire a vacation property. To assist with this purchase, he has asked the management of Stern for a $350,000 interest free loan. At this time the mortgage rate for vacation properties is 4.5 percent and the prescribed rate is 2 percent. Stern is subject to a marginal tax rate of 26 percent and has alternative investment opportunities that earn 7 percent before taxes. Should Stern Inc. grant the loan or, alternatively, provide sufficient salary to carry an equivalent loan from a commercial lender? Explain your conclusion.

John Baxter Is a Highly Valued Employee of Stern Inc